AUDIT EXAMINATIONS ON EXCESSIVE
cost of issuance for private activity bonds, defeasance, and public safety or jail bonds are part of the Internal Revenue Service compliance strategy for the 2019 fiscal year that began Oct. 1
WASHINGTON -- Audit examinations on excessive cost of issuance for private activity bonds, defeasance, and public safety or jail bonds are part of the Internal Revenue Service compliance strategy for the 2019 fiscal year that began Oct. 1.
All three areas are new additions to the work plan of the Tax Exempt and Government Entities Business Operating Division, IRS officials said.
David Horton, the acting TE/GE commissioner, and Robert Choi, the acting deputy, included the compliance strategy in a 2019 program letter posted on the IRS website.
Last year the 2018 IRS work plan for the division included hedge terminations; economic life and weighted average maturity); safe harbors for guaranteed investment contracts; and rules for qualified hedges.
The IRS declined comment on the shift in audit priorities for 2019, but Ed Oswald, a tax partner at Orrick Herrington & Sutcliffe in Washington, said it’s normal.
“Each year strategically they generally focus on different subjects,” Oswald said. “Perhaps if there is a problem they continue.”
Excessive cost of issuance that would adversely impact the tax-exempt status of private activity bonds was the topic the IRS most recently covered in an “issue snapshot” that was published on its website.
The July 27 issue snapshot provided 10 examples of costs that are subject to the 2% limitation on issuance costs as well as several audit tips.
“I think that’s an interesting tie-in,” said Vicky Tsilas, a partner at Ballard Spahr who recently headed Branch 5 in the IRS Chief Counsel’s Office. “The IRS has been publishing snapshots, which are basically two pages, and folks have been asking, ‘Do these actually signify what the IRS is going to be targeting?’ and the IRS says, ‘Well, not necessarily.’”
Oswald said the 2% cost of issuance limitation for PABs could be “a fruitful area” for IRS enforcement. “Given that the 2% limit is a bright line, for a regulator to look at it, is certainly reasonable,” he said.
Violations of the 2% limitation may be most likely for smaller issuances. Oswald said the 2% limitation might be met at the closing, but a few weeks later the issuer may get another bill and pay it, resulting an unintended error.
Notices of defeasance are required to be filed with the IRS. For instance, a university might have issued tax-exempt bonds to pay for construction of multiple buildings, but years later decide to sell one of them and defease the bonds by taking them off the market.
Oswald speculated that the IRS will review those filings to determine whether the conditions were met and double check the math.
As for public safety bonds, Tsilas said she interprets that compliance area as focusing on “the jail facilities and they have been auditing those for a couple of year now.”
The Bond Buyer has reported on several audits where tax-exempt bonds issued for jails and detention facilities have been determined to be taxable because of an excess private use of the facility. Often it has involved contracts issuers or borrowers have with the U.S. Marshals Service or U.S. Immigration and Customs Enforcement to house federal prisoners being detained as undocumented immigrants.
“Over the last three years, I would say the IRS has been targeting these jail facilities and The Bond Buyer has reported on them,” Tsilas said. “To me it signifies they don’t intend to let up on these audits.”
Oswald agreed “this is maybe a little more of the same because they found some problems there and are looking more.”
“For people not steeped in this, everyone kind of knows what private business use is,” Oswald said. “When you emphasize that the federal government is treated as private business use, people are often dumbfounded by that, asking, ‘How can that be?’”
The choices made by the IRS for its audit priorities have become “even more of a black box” since the service began using a data drive approach, said Todd Cooper, a partner at Locke Lord who chairs the American Bar Association’s taxation section’s tax-exempt financing committee. ◽
Vicky Tsilas, Ballard Spahr partner, said the IRS won’t let up on jail audits.